By Atul Aggarwal and Brian Sammut, Accordion
“I don’t understand a word you just said.” If you like the misfit-turned-hero genre of film, you’ll recognize the line from Napoleon Dynamite. But even if you don’t, you’ll appreciate the quote’s applicability to private equity’s buzz-term du jour: digital transformation.
Operating partners, deal partners, management and LPs have all embraced the role technology plays in deal success, exit price, and valuation. But ask five different PE stakeholders what digital transformation really means and you’ll get five different answers.
We’re here to give you one: Digital transformation is the tech-enablement that supports an investment thesis. It’s not the adoption of the latest software. It’s a plan for the strategic application of digital initiatives designed for an investment’s desired end-state.
Or, as a one operating partner recently said, “Digital transformation is not value creation. It’s the ‘how’ behind the existing VCP – the ‘how’ behind growing the portfolio company, acquiring new markets, building new products, and getting the right margin structure.”
That ‘how’ takes many different forms:
The how can be the digital transformation of the company’s financial infrastructure and backbone, in the form of an ERP implementation which can help speed close and improve performance reporting. It can also help facilitate a virtual or touchless finance function for a new remote paradigm.
It can be the capture of multi-channel product performance and salesforce effectiveness into digital dashboards in order to arm management with real-time metrics to inform product and sales strategies.
It can be digitization to enable more effective market share expansion: the replacement of existing bespoke platforms with standardized architecture to more seamlessly absorb add-ons, ensure greater data governance post-integration, and provide more accurate forecasting and reporting for the combined entity.
Whatever the form, sponsors and management must be mindful of digital transformation’s three Ts that, when appropriately addressed, can help accelerate success or, when ignored, can lead to a very expensive and unproductive exercise. They are:
Timeline: The traditional question is: Will we recoup the investment during our hold period? Answering ‘yes’ usually assumes an initiative that has a relatively quick ROI, like the application of business intelligence tools. But those light-touch, quick-return initiatives are digital unicorns. The more common (and transformative) undertakings take time and money – time that may not be built into the hold period. When investment return and implementation completion do not align with investor timelines the initiative is frequently shelved. But there’s a more unorthodox question that sponsors should consider before closing their wallets: Will the undertaking – ongoing though it may be – impact the attractiveness of the company to the next buyer? It’s not the traditional ROI paradigm, but it can be an equally effective lens through which to consider digital dollars.
Conclusion: Don’t invest in late-stage digital initiatives…unless you can identify and showcase the digital proof points for the next buyer.
Talent: The very next question for any digital investment must be: Do we have the right talent? That talent comes in two forms. First, there’s the talent from the sponsor, many of whom have invested in technology-dedicated operating partners to help navigate digital initiatives across the portfolio. Other PE firms, however, have decided that digital transformation is too broad a bucket for one OP, given the variety of expertise required and the industry and functional specificity of many of the initiatives. Moreover, they have concluded that a dedicated resource at the firm-level can only be effective when it has a peer-like executive at the portfolio company with whom to interact or engage.
Conclusion: Map your talent to your type of enterprise digitization. If you are a ‘little dt’ company then your digital strategy consists of various initiatives across the organization supporting the VCP. You’ll need multiple executives with digital expertise. But, if you’re a ‘big DT’ company (that rare breed wherein digital transformation isn’t just the how, it’s the headline), you’ll need more. You’ll need to invest in a centralized, senior, C-Suite-adjacent digital officer.
Technology: Finally, there is the question of the technology itself. What platform/software to invest in to underwrite digital transformation? The answer depends on a myriad of factors and the evaluation of whether the company needs an entirely new platform or can MacGyver a solution with a combination of BI tool overlays and system upgrades. But ‘what’ probably shouldn’t be the first question asked. The better query is whether the portfolio company needs new technology at all.
Conclusion: Before you invest in tech, take a hard look at the process. Sometimes, the right technology already exists, it just hasn’t been deployed effectively. But if, after review, that tech purchase is actually warranted, bring in the technologists early to help formulate strategy – they not only ensure that enterprise infrastructure can support desired initiatives, they can also suggest new digital pathways to value capture.
Atul Aggarwal and Brian Sammut are president and managing director, respectively, at Accordion, the PE-focused financial consulting and technology firm.